Construction Law Update: Iowa Court of Appeals Strengthens Defenses Against Liquidated-Damages Claims
On July 27, 2016, the Iowa Court of Appeals issued a decision in Carroll v. REO, L.L.C., 2016 Iowa App. LEXIS 735 (Iowa Ct. App. 2016) that strengthens contractors’ potential defenses against liquidated-damages claims. Although the case is set in the context of a dispute between a realty company and a realtor, the ruling is applicable to the construction context.
Iowa law enforces liquidated-damages clauses so long as they do not constitute a penalty. In general, a liquidated-damages clause is a penalty if it fixes an unreasonably large amount of liquidated damages. In determining whether a clause is a penalty, Iowa courts focus on the following two factors: (1) the anticipated or actual loss caused by the breach; and (2) the difficulty of proof of loss. Rohlin Constr. Co. v. Hinton, 476 N.W.2d 78, 80 (Iowa 1991). Typically, courts have found a liquidated-damages amount “reasonable to the extent that it approximates the loss anticipated at the time of the making of the contract, even though it may not approximate the actual loss.” Aurora Bus. Park Assocs., L.P. v. Michael Albert, Inc., 548 N.W.2d 153, 155 (Iowa 1996). As a result, courts traditionally have not focused on the actual amount of loss suffered but instead on the anticipated loss at the time the parties entered into the contract. The Carroll case bucks that tradition and holds that courts should focus on both.
In Carroll, a realtor sought to have declared unenforceable a liquidated-damages clause in an independent-contractor agreement with a realty company. The district court declared the clause an unenforceable penalty, and the realty company appealed. On appeal, the realty company argued that the “district court erred in comparing the liquidated damages to actual provable losses rather than to the anticipated loss at the time of the contract.” The Iowa Court of Appeals rejected that argument and concluded that the district court properly “considered both the anticipated and actual losses, noting ‘the record contains insufficient evidence to establish what the anticipated or actual losses would be’ and thus ‘[t]he evidence did not establish that [the liquidated damages] bore a reasonable relationship to the anticipated losses or actual losses.’” Carroll, 2016 Iowa App. LEXIS 735, at *10. The Court of Appeals stressed that “[e]ven, as here, where the contract calls for liquidated damages, ‘[a] party is not entitled to use the breach to better its position by recovering damages not actually suffered.’” Id. at *6. The Court of Appeals, therefore, agreed that the clause was an unenforceable penalty.
The Carroll case is an important and valuable tool that contractors should utilize in defending against owners’ liquidated-damages claims. It provides contractors with a potentially valid defense when the amount of liquidated damages is not reasonably proportional to the actual loss suffered by the owner. The Carroll case, however, may not be the last word on this issue. The Iowa Supreme Court, as the highest court in the State, will have the last say. But until and unless the Supreme Court issues a decision contrary to Carroll, contractors should definitely utilize the Carroll case.